Simon Barry

A flurry of comments from Fed speakers over the past 24 hours or so have exuded a decidedly hawkish tone, at least relative to the very benign set of expectations currently embodied in US interest rate market pricing.

A flurry of comments from Fed speakers over the past 24 hours or so have exuded a decidedly hawkish tone, at least relative to the very benign set of expectations currently embodied in US interest rate market pricing.

A flurry of comments from Fed speakers over the past 24 hours or so have exuded a decidedly hawkish tone, at least relative to the very benign set of expectations currently embodied in US interest rate market pricing.

Atlanta fed president Dennis Lockhart said that financial markets are being overly pessimistic about the US outlook and may underestimate the chances of an interest-rate increase as soon as June. San Francisco Fed President John Williams said it still “makes sense” for the central bank to raise short-term interest rates two or three times this year given continued moderate U.S. economic growth and low unemployment. And their counterpart at the Dallas Fed, Robert Kaplan, said that the U.S. economy is strong enough to justify an interest-rate hike in the "not too distant future", but added that increases will be very gradual. He noted that Inflation is "inching toward" the Fed's 2% target, and while there is still slack in the U.S. labour market, 2% GDP growth this year will likely push unemployment below its current 5% level.

While none of these regional Fed Presidents have a vote on the FOMC this year, and with the possible exception of Williams (who in the past has been seen as someone whose views have tended to broadly align with Yellen) neither are they considered part of the core nucleus of key policy shapers at the Fed. Nevertheless, the views expressed by Williams et al. yesterday are very much consistent with the central message from the Fed of late which is that if the economy and its outlook evolve in line with expectations, then two rate hikes are likely to be delivered this year. Ordinarily, various restatements of previously-communicated policy intentions would warrant little attention. However, the context here is the fact that markets are not even fully priced for one hike this year. And it is beginning to look and feel like Fed communications are becoming a bit more assertive in reminding markets of the likely path for rates.

In turn of course, the incoming data are what drives the attitudes and communication tactics of policy makers at the Fed and yesterday’s figures were a case in point. Industrial production rose by more than expected in April, with manufacturing output up 0.3% (after a 0.3% drop in March), consistent with stabilisation in the factory sector. Meanwhile, on the prices side, headline CPI inflation rose from 0.9% to 1.1%, while the core rate inched down from 2.2% to 2.1% as expected, though came very close to surprising to the upside. Our overall take on where the US economy is at right now is that GDP growth looks to be on track for a much better Q2 (likely ca. 2.25%) after a sluggish Q1, while inflation trends look steady and firm (but not sharply accelerating). This underpins our view that US rate markets are likely underestimating what the Fed will deliver this year – an observation that in turn is an important part of the rationale for expecting the dollar to gain in the weeks and months ahead (targeting ca. $1.08 in Eur/USD). Indeed, the greenback has firmed a touch over the past 24 hours, rising by about 0.3-0.5% against the euro and pound, opening at $1.1265 and $1.4440 respectively.

The Fed policy outlook remains in focus today as we get the Minutes of the FOMC’s April meeting later this evening. This will form an important part of the policy roadmap as markets look to understand the likely conditions necessary for further policy tightening, possibly as soon as this summer. Although we think that it is highly unlikely that the Fed will, at this stage, indicate any firm intention to hike imminently, we do think that there is potential for them to take the first few tentative steps towards teeing up markets for the possibility of a summer hike.

Meanwhile in the UK, inflation figures were weaker than expected. Headline CPI dipped unexpectedly from 0.5% to 0.3% y/y in April, while core (ex. energy, food, alcohol, & tobacco) inflation fell more sharply than expected, from 1.5% to 1.2% y/y in April. While some payback was expected after Easter-related discrepancies boosted the March numbers, the main downside pressure stemmed from a (sharper-than-expected) reversal in airfare inflation. The other main downside influences were clothing & footwear, and housing rents.